Peak Demand or Peak Consumption? A Look at OECD Oil Demand

Posted by Sam Foucher on November 11, 2009 - 10:19am

Standard
economic
principles have demonstrated that price is a function of supply and
demand. The same is true for the recent oil prices
fluctuations
we have witnessed over the last few years, namely the
equilibrium between supply and demand. However, the following conundrum
has not been resolved: are
oil
prices high due to greater demand or too little supply?
This ambiguity allows for vastly divergent interpretations of
the
same data and depending on the agenda you are trying to push, will
easily support either.

Lately,
the
concept of "Peak
demand"
has been suggested in a multitude of recent articles that
unfortunately do not qualify their analysis of the status quo. Some
suggest that we are willing to and capable of moving
away
from oil. Are we?

A
few years ago, some analysts lectured us about the effect of
oil prices on the creation of new oil
supply. Now that this argument
has clearly failed, they have decided over night that we
don't need oil anymore. In this debate, it is important to distinguish
between
demand
(what you want or need) and
consumption (what you get based on your ability to buy). Following this
logic, consumption is "satisfied demand". Conversly, we can
define the "unsatisfied
demand" or "excess demand" that has been suppressed. Below the fold,
I'll show that the key driver behind the price increase since 2002 has
been excess demand combined with unresponsive supply.

OECD Demand

In this analysis, I follow an approach similar
to the one proposed by Ye et
al.
(pdf)
using a model defining a desired inventory level. The consumption trend
observed between 1990 and
2001, when the market was well supplied, can be easily and accurately
modeled by a
linear trend taking into account monthly fluctuations:

The fit result is shown as the
magenta line illustrated on Figure 1
below.
The above model will define normal demand levels assuming low oil
prices. The OECD consumption has strongly reacted to higher oil prices
and is now almost 10 mbpd the level expected by my nominal demand
model.

Figure
2. Observed OECD consumption and nominal demand model
(monthly, total petroleum
products), volumes in million barrels per day (mbpd). data from the EIA.

Looking at the residuals Ct-Dt,
the
fall in consumption from the desired level is even
more telling:

Figure 3. Difference between the nominal demand
models and the observed consumption
(monthly, total petroleum
products), volumes in million barrels per day (mbpd). Data from the EIA.

I make the
following assumptions:

because oil prices were so
low during the 1992-2001 period
(i.e. virtually no excess demand), I will call "nominal
demand model" the linear
model defined above.

The difference between
nominal demand and observed
consumption is an estimate of the excess
demand: EDt=Dt-Ct

Plotting the excess demand
against oil prices clearly shows why
prices rose until the financial collapse last year. Before 2002,
prices and excess demand were contained within a tight cluster around
20$/barrel - evidence that the market was well supplied and at
equilibrium. The red line shows that prices increased by $20
per 1
million barrels per day of excess demand between 2004 and 2008.

Figure 4. OECD Excess demand versus oil prices
(WTI).

One could argue that the
nominal demand model
defined above is not stationary and has been affected by structural
changes in demand. Unfortunately, the only way structural changes in
demand could be
estimated is if the oil prices of tomorrow would go back to $20 a
barrel
for a few years within a
pro-growth and healthy business
environment. Only then could a new nominal demand model be
estimated; those conditions won't be satisfied
anytime soon.

Peak demand would suggest that the demand model would change
over time,
but then the level of unsatisfied demand would go down, bringing down
prices with it. Actually, the severe recession we are currently in
since the fall of 2008 has
destroyed demand as a result of high unemployment
rates and reduced credit availability. Looking at the price
model on Figure 3, a return to the $70-80 range is equivalent
of
a demand
destruction of around 3 mbpd for all of the OECD.

What about Spare Capacity?

Spare capacity, mainly provided
by OPEC, is the amount of oil that
can be made available within 30 days and sustained for at least 90 days
(EIA definition). Looking at the available spare capacity and
the excess demand estimate, it is obvious that OPEC
spare
capacity has become deficient since 2002, and that the surge in excess
demand
coincides with the increase in oil prices as shown on Figure
5.

So What is Causing High Oil
Prices?

As an interesting exercise, I looked at
the causation between oil prices and
demand/supply indicators. Causal search algorithms systematically
investigate
patterns of conditional dependence and apply the Causal Markov
Condition to reconstruct the graph of the data generating process (A
good overview is
available here).
I define the following
quantities:

P:
Monthly oil prices

S:
Monthly oil supply

C:
OPEC spare capacity (EIA)

D:
Excess demand

I used the remarkable TETRAD
IV software (family of software
for causal modeling
originating with Peter Spirtes, Clark Glymour, and Richard Scheines at
CarnegieMellon University) available online. I split the dataset in
two periods: 1998-2002 period when prices where relatively low and
2003-2008.

1998-2002
period:

Figure 6. Graphical causal model for the period
1998-2002

Spare capacity is dependent on prices and excess demand. Prices
and excess demand are independent unconditionally; but are
dependent conditional on spare capacity. In short, OPEC spare capacity
was playing a buffer role in order to absorb excess demand.

2003-2008
period:

Figure 7. Graphical
causal model
for the period 2003-2008

Prices is dependent on supply and excess demand. Supply
and excess demand are independent unconditionally; but are
dependent conditional on prices. Spare capacity is independent
of all the other variables at 5% significance.

Conclusions

Lower consumption does not mean lower demand, nor does it mean the
increase in alternate sources of energy. If it did, it would be akin to
saying
that an alcoholic is sober implies he
has effectively dealt with his addiction. It may be that he is
sober
because he
has simply exhausted all of his options for obtaining additional
alcohol. Also, I think it is important to differentiate
between
the following two causes of demand destruction:

In my opinion, the latter cause of demand destruction is the approach
to take
and can be implemented through adequate government policies
(e.g.
higher CAFE standards). When people are unemployed, energy efficiency
is the last of their concerns. If
we do not proactively implement demand side policies and instead wait
for
high prices to take their toll, social unrest and
higher
government deficits are likely to make things more challenging, or even
completely unmanageable. Anemic
supply growth, only a
preamble to peak supply, was enough to create our present troubles.
Wait until
supply growth is negative!

We have enough data from the OECD to draw the following conclusions:

Sluggish supply growth is
the main driver behind the
2002-2008 oil price increase. OPEC spare capacity has become
irrelevant or at least unresponsive.

Nominal demand is between 3
and 5 million barrels per day above
production capacity.

Prices are increasing by $20
for every million barrels per day of
excess demand.

OECD consumption is very
elastic to oil prices.

Non recession induced peak
demand is not supported by the
data.

The financial collapse and
the current economic recession has at
least reduced demand by 3 million barrels per day for the OECD.

Sam -- I'm sure all appreciate your effort. Took some time no doubt. A question that perhaps you can only answer qualitatively: China has been acquiring rights (via contracts and direct ownership) of oil production around the globe for some time. The volume is difficult to estimate but the amount would seem to represent a reduction in the supply side of your model at least for the rest of the consumers out there. Of course, it also represents a volume that China wouldn't have to acquire on the open market. Can you offer any hint to the potential magnitude of this situation with respect to your model?

I was supposed to look at it in this post but that was way too long for a single post, part 2 will be posted tomorrow and will look at the Non-OECD demand. I think the Non-OECD is effectively outbidding oil through various mechanisms (not open market mechanisms).

"Some suggest that we are willing to and capable of moving away from oil" - I can see that those who are into wishful-thinking would like to interpret the recession induced reduction in demand as a signal we are safe from our dependence on oil. It is just that: wishful thinking.

(Now everyone can see why Sam does the mathematical heavy lifting on our joint papers.)

It probably helps to show some specific examples, especially in regard to the export market. Saudi Arabia, at least based on annual data through 2008, is world's largest net oil exporter; the US is the largest OECD net oil importer and China is the largest non-OECD net oil importer.

I think that the Saudis tried--as best they could--to restrain the price of oil from 2002-2008, and they significantly increased net exports from 2002-2005, but then from 2006-2008 their net exports fell below the 2005 rate, with 2008 (when oil prices averaged $100) actually falling below their 2004 net export rate (when oil prices averaged $42).

As one would expect, US consumption and net imports fell, in response to higher oil prices, but then we have China (their most recent data show monthly net imports of about 4.5 mbpd).

1. "A few years ago, some analysts lectured us about the effect of oil prices on the creation of new oil supply. Now that this argument has clearly failed...."

2. "Lower consumption does not mean lower demand."

1. Higher prices have resulted in new supply. All that oil sands production and Brazilian ultra deep oil would not be produced if prices were $20 per barrel. Maybe you mean that the new supply resulting from higher oil prices has not been as abundant as analysts predicted?

2. Aren't consumption and demand the same thing. Demand (consumption) is a function of (a) oil prices and (b) available infrastructure to burn oil, among other factors. For every price there will be a different level of demand. In 2008, prices rose to levels which reduced demand (consumption).

Perhaps your definition of demand is different in that it ignores price and you define it as infrastructure available to burn X barrels per day of oil, which is not being run at full capacity. Therefore, because of idled oil burning infrastructure (such as airlines being stored in Arizona), your definition of demand is not being met. This is a non-standard definition of demand as it is more of a definition of infrastructure capacity to consume oil - which is vastly higher than 100 million barrels per day, compared to current consumption of around 85.

"Peak Demand" is the same as "Peak Oil" Supply, with the two linked via price.

I guess despite the sarcanol tag my comment is still being over analyzed...

In economics, demand is the desire to own anything and the ability to pay for it and willigness to pay. (from Wikipedia)

If I'm very thirsty I desire water (need it) and if I have to drink and I'm able to, I will pay a premium for it!

Consumption is is the actual amount of water over time that ends up going down my throat. This actual quantity can be used to predict future demand.

If there is not enough water (not enough supply) to meet future demand,regardless of willingness and ability to pay, at some point you are actually going to die of thirst. You can't consume what is not available regardless of how much you might be willing to pay.

Consumption vs. Demand
When speaking about electrical energy, there are two related, yet different, measurement parameters that need to be understood: consumption and demand.

Consumption is a more familiar concept for most people. Simply put, it is the total amount of energy used. Demand is the immediate rate of that consumption.

A simple analogy is a pile of rocks of various sizes and weights. Let's say that you were moving the pile. The total weight of the rocks is similar to the consumption because it represents the total energy you would expend. The weight of the largest rock is similar to the demand because it represents how much power you would need to have "available" to move that one rock at that instant in time.

Mathematically, energy consumed is represented by kilowatt hours (kWh). These are what the electric meter records as the dials turn. The rate of consumption would be kilowatt hours per hour or just kilowatts (kW). Typically electric demand is not measured for residential customers. However, commercial customers are charged for both the energy used and how fast they use it. The faster the collective customer base uses energy the more the utility must be able to supply.

How much energy the system must be able to generate to meet the instantaneous load (even if it's only for a short duration) is called its capacity. This concept is also used when designing a system or building so that electrical distribution equipment is properly sized. The capacity of a utility must be able to meet the demand so no customers are deprived of their electricity.

Everyone probably knows somebody who can't turn on their toaster and microwave at the same time without blowing a fuse. This example demonstrates a circuit that does not have the capacity to meet the demand. However, if these devices are operated one after the other, the energy would be readily available.

Sp the problem with the electrical power analogy is that the electricity supplied "clamps" at the maximum power distributed. So you can only tell that people are requesting the maximum allowable; yet you can never tell how much they would use if they clamp was not there. I suppose there are ways to infer this based on how fast the requests increase (say in times of a heat wave) but the asymptote will never be known unless it stays below the clamp.

Unless the ground rules have been changed since the late sixties demand was defined as a FUNCTION of price ceretus parabus (sp?).

In plain language everything else held equal or staying the same, consumers might "demand" eighty five million barrells per day at eighty dollars a barrell .

At one hundred dollars a barrell they would use and "demand" considerably less, perhaps only eighty two million barrels.

If the supply is readily available the same consumers might "demand" one hundred million barrells at fifty dollars per barrell.(All these numbers are thin air numbers)

Obviously such models don't correlate very well with the real world but they do illuminate things well in a "snapshot " fashion.

"Things" cannot stay the "same " for very long of course.There are uncountable random and systematic changes taking place constantly and any big change in such an important part of the economy as oil supply is sure to set numerous feedback loops in motion.

In the theoritical world suppliers are numerous and have the resources to expand production as prices rise.It is recognized that increased production will come at increased cost so as prices rise more and more marginal producers come into the market.A "marginal" producer is one whose costs are high and who can only survive in a high price market.

The producer or supply side of the model is also a snapshot model rather than a movie model.

Things cannot stay the same very long on the producer side of the supply demand model any more than they can on the demand side.

In the real world the APPETITE (I use this word for clarity) for oil is continiously increasing as we get wealthier and more numerous-we would all (enough of us, anyway) like to own a big house, a large fast comfortable car, eat strawberries and grapes in the winter , and fly to the sun or the snow as the whim strikes us.

We buy as much oil as we can afford.

Most wordsmiths are such clumsy workmen that the world is thorughly confused concerning these simple definitions in much the same way as inflation is differently defined by the man on the street, financial specialists/writers, and non specialist writers-run of the mill reporters,bloggers, commentators,etc.

Suppliers are in a more complicated situation.

In a "snapshot" description oil prices do correlate theoritically with price-on any given day, there is some shut in production or jusy about ready to go production that can come to market , or be withdrawn from the market, as the price goes up or down,making it either profitable or unprofitable as the case may be, to produce these last few marginal barrels.

But the world is a movie, not a snapshot.

And while the pastors of the Church of Progress and Perpetual Growth assures us that supply can grow forever the folks who study such worldly subjects as biology and geology are pointing out that since the earth is not infinitely large, then the supply of oil must necessarily be limited, excepting the possibility (zero or close enough) of abiotic oil.

Any serious recreational fisherman knows how this game plays out-the big fish near home are the first to become scarce.Then you burn a little more gas in bith the truck and the boat to fish a second class lake. getting less fish per hour and per dollar invested.Third class lakes pay an even poorer return on the fishing hour and fishing dollar invested.

I go to the trouble of putting this up not to insult the regulars who post comments but for the unknown number of ordinary people , many of them well educated, who can make little or no sense of arguments using technical language with which they are unacquainted.I estimate the number of these people at somewhere above eighty five percent of the population of the US.

The easy oil is gone.The tough oil is obviously too expensive to produce to come to market at todays prices, else it would be on the market, allowing for the necessary time lag.The old fields are rapidly running dry.The population is growing , not shrinking.

Substitutes for oil , or near substitutes, such as the electric automobile , will take years of "movies" to have any real effect, if they ever do.
Conservation efforts will at best slow the arrival of the worst effects of continually declining production and continually rising prices.

TSIS in TF.

It may take the public another year or two to realize it.But in historical terms a year or two is but the blink of an eye.

This is as near to plain language as I can get.

Sam has done a fine job without a doubt.But the last time I had to solve a calculas problem was around 1970.I could , with the help of a text book or two, and maybe a few minutes tutoring here and there really follow his arguments SPECIFICALLY, rather than generally.

I expect that even most of the regulars here are in the same boat, excepting the engineers who are numerous , in relation to the number of folks who post comments.

damn mac, that was beautiful. your existential bend gets more direct daily. reminds me of camus's the Stranger story, you empty us of hope, which is something we all need to do, and open our hearts to "the benign indifference of the universe." the "howls of execration", by the masses is assured.

This does not mean that the link between higher prices and increased supply is broken.

Texas & the North Sea accounted for about 9% of total cumulative oil production through 2005, and their respective peaks are lined up with each other (1972 for Texas and 1999 for the North Sea). The initial nine year production declines in both cases corresponded to roughly ten-fold increases in oil prices. Based on the logistic models, mathematically Saudi Arabia in 2005 was approximately at the same stage of deletion at which the prior swing producer, Texas, peaked in 1972 (and like Texas showed lower production in response to higher oil prices), and world conventional production in 2005 was at about the same stage of depletion at which the North Sea peaked in 1999.

Incidentally, some preliminary work that Sam has done shows that if we look at the North Sea oil fields whose first full year of production was 1999 or later, i.e., just coming on line, these 1999 and later oil fields showed peak production of one mbpd in 2005 (as total North Sea production fell from about 6 mbpd in 1999 to about 4 mbpd in 2008). So, you are technically correct that there was a supply response to the rise in oil price, but was there a net increase in supply?

And as I have pointed out, once or twice now, Texas & the North Sea were developed by private companies, using the best available technology, with virtually no restrictions on drilling.

One argument I've come across is that cheaper overseas oil led to a lack of investment in the US, hastening the peak. This does nothing to explain why the madcap drilling of the 1980s did little to raise lower 48 production much. Here's a telling quote from a 1972 news clipping as well:

"We (the commission) feel this to be an historic occasion - damned historic - and a sad one," said Byron Tunnell, chairman of the Texas Railroad Commission which sets the state's oil allowable.

"Texas oil fields have long been like a reliable old warrior that could rise to the task when needed," Tunnell said. "That old warrior can't rise any more."

The Bulletin - Mar 17, 1972 The cornucopians would tell you this was indicative of that lack of investment as well - OK, how much difference would it have made, with that groovy out of sight skyrocketing late 60s demand? Are these Lynchs and Hubers seriously suggesting the US should be producing 10 mb/d today if only these detestable command economy types would have let things well alone? And how would they have dealt with the glut coming East Texas in the 30s that led to the TRC stepping in in the first place? Free markets weren't working at all in that atmosphere.

For that matter shouldn't have all that prorationing stretched things out further than normal in the first place? Funny how they use that as an argument for continued OPEC production but somehow it doesn't apply to Texas.

KLR -- I can tell you from firsthand experience what that "madcap drilling" of the late 70's+ drilling boom accomplished. I started working in 1975 so I was there for the build up to the collapse. Those high oil prices and skyrocketing drilling rig count did more to damage the oil industry then any event in my 34 year career. The rig count topped out at 4600. And I promise you at least half those rigs were drilling crap with little or no chance of success. Countless companies and drilling funds went out of business when the bubble burst. There may have been some improvements in production rates, especially NG since such plays had been grossly underdeveloped in previous decades due to extreme low prices. But for the money spent (actually wasted) the results were pathetic. And if you look at where most of the big gains originated it was in the Federal offshore plays in the GOM. Offshore drilling was just getting big in the early 70's due to technological advances. Those days are now long past. In recent times the Deep Water plays are mimicking that profile. I believe DW GOM accounts for 40% of offshore oil production these days. There's more to drill out there but their day will pass just as it did for the shallow water trends.

IMHO anyone who harbors great expectations that a spike in oil/NG prices will generate a cornucopian boom in production will be just as disappointed as all those folks who lost big time back in the 70's boom. In fact, I'm a little surprised that the boom of the last few years didn't draw in a lot more "stupid money" (that's is actually the technical term we use for those types of investors). Perhaps the boom didn't last long enough. Or maybe the memory of that last slaughter still lingers.

Yeah, I've graphed out US lower 48 production and imports and you can see how all those holes led to a very minor uptick, nothing to write home about at all. Here's an outstanding analysis of that era: Relationship of Oil Drilling and Oil Production. Maybe the Lynch mob will then say that tech has advanced to the point where we can make real gains this time, via 4D seismic, horizontals, etc. Think there's any validity to that? It hasn't done much for all the workovers in the interim, US production declines something like 145 kb/d every year average. Although the onshore average is gentler I'd imagine. The Obama administration's hostility to O&G won't help that, though.

It really strikes me as if the current administration is kicking the spurs to get to the next energy crisis that much quicker. Are they trying to stave off the worst of AGW? Or figuring that the sooner we get it over with the better? People talk about the financial crisis in those terms, after all, or dealing with the flu for that matter. It's not surprising at all that we don't get flat out pronouncements about their intentions.

It really strikes me as if the current administration is kicking the spurs to get to the next energy crisis that much quicker. Are they trying to stave off the worst of AGW? Or figuring that the sooner we get it over with the better? People talk about the financial crisis in those terms, after all, or dealing with the flu for that matter. It's not surprising at all that we don't get flat out pronouncements about their intentions

I think its just that their recruitment pool is heavily dominated by the crowd that thinks all Oil and Gas companies are evil. And clearly, politically these companies have largely been helping their opposition, so it is only natural that their biases tend in the anti
direction. Then they have their base of supporters, who are vehemently against offshore.

Secondarily, compared to the drill-drill-drill party, even a well balanced approach to the subject would create a lot of selfserving whining by the industry. So at least a part of what you are picking up on probably comes from that dynamic.

Maybe the Lynch mob will then say that tech has advanced to the point where we can make real gains this time, via 4D seismic, horizontals, etc. Think there's any validity to that?

The dispersive discovery model assumes an exponential advance in technology leading to an exponential advance in search rates. It doesn't help because the role of diminishing returns more than cancels that effect out. It is striking on how the math works out on this.

Excellent observation, and one that is well supported by the geologic evidence:

Rich deposits of minerals historically were found scattered over the earth's crust as if a creator were scattering jewels. Each discovery produced a moment of economic bonanza, a boom town, and then a bust. Many publications have dealt with the typical pattern of mineral distribution and concentration of many deposits of low concentration and few deposits of high concentration. Economic geologists found that the distribution of mineral concentrations was highly skewed, a pattern often fit by a lognormal distribution equation.

From "Environment, Power, and Society for The Twenty First Century: The Hierarchy of Energy" by Howard T. Odum

Good link KLR...thanks. Actually there have been significant advances but I don't think those cornucopians would like the second part of my answer. Hold your breath and hear me out: oil/Ng has NEVER been easier to find or more efficiently produced then today. On the exploration side 3d seismic has been truly magical. But 3d seismic has killed more potential drilling projects then it has aided. This technology is so powerful today that most operators, especially in the offshore arena, won't even look at a deal let alone drill it if there isn't 3d control. But being so much more efficient in the exploration process doesn't mean you'll find that much more oil/NG. Just means you'll be more efficient at it. You can't find wasn't isn't there. But we can find/produce what is there with much fewer wells. That's one reason I doubt we'll ever see the stupidity of the 70's drilling boom repeated to the same degree. Then a lack of concrete evidence allowed rampant speculation. Not very easy to do now with the new exploration tools.

Same goes for the production side. Horizontal wells have been another magic trick. Such wells can increase the ult recovery in many reservoirs but they do so at such a high production rates they give the illusion we've found much more then there really is there. Some secondary recovery applications for sure but the cream has already been produced. A little, but often very profitable, bump.

A far as hostility towards the oil patch from DC or the general public that's pretty much a non-issue for us. We've been those "evil greedy bastards" since at least 1975 when I started. We don't even hear the verbiage anymore. And to be brutally honest, the last thing the oil patch needs is for the gov't to "help" us. Just look at how well they've helped the rest of the economy.

The price of oil produced in USA from around late 1971 to about 1974 was 'capped' -

"...whatever the effects of the Vietnam War on the national consensus in the 1960s, confidence had risen in the ability of government to manage the economy and to reach out to solve big social problems through such programs as the War on Poverty. Nixon shared in these beliefs, at least in part. "Now I am a Keynesian," he declared in January 1971...He introduced a Keynesian "full employment" budget, which provided for deficit spending to reduce unemployment....

"He attributed his defeat in the 1960 election largely to the recession of that year," wrote economist and Nixon advisor Herbert Stein, "and he attributed the recession, or at least its depth and duration, to economic officials, 'financial types,' who put curbing inflation ahead of cutting unemployment."

Looking toward his 1972 reelection campaign, Nixon was not going to let that happen again.

So the central economic issue became how to manage the inflation-unemployment trade-offs in a way that was not politically self-destructive; in other words, how to bring down inflation without slowing the economy and raising unemployment. One approach increasingly seemed to provide the answer -- an income policy whereby the government intervened to set and control wages...

in May 1970..Arthur Burns, whom Nixon had appointed to be chairman of the Federal Reserve....declared ...The economy was no longer operating as it used to, owing to the now much more powerful position of corporations and labor unions, which together were driving up both wages and prices.... fiscal and monetary policies were seen as inadequate. His solution: a wage-price review board,...who would pass judgment on major wage and price increases.

A second issue was also now at the fore -- the dollar. The price of gold had been fixed at $35 an ounce since the Roosevelt administration. But the growing U.S. balance-of-payments deficit meant that foreign governments were accumulating large amounts of dollars -- in aggregate volume far exceeding the U.S. government's stock of gold. These governments...could show up at any time at the "gold window" of the U.S. Treasury and insist on trading in their dollars for gold, which would precipitate a run.

The issue was not theoretical. In the second week of August 1971, the British ambassador turned up at the Treasury Department to request that $3 billion be converted into gold.

...Out of this conclave [Camp David retreat, 13-15 August 1971, present Nixon plus 15 advisors] came the New Economic Policy, which would ...freeze wages and prices [for a 90-day period] to check inflation. That would...solve the inflation-employment dilemma, for such controls would allow the administration to pursue a more expansive fiscal policy -- stimulating employment in time for the 1972 presidential election without stoking inflation.

The gold window was to be closed...But this would accentuate the need to fight inflation; for shutting the gold window would weaken the dollar against other currencies, thus adding to inflation by driving up the price of imported goods.

...After the initial ninety days, the controls were gradually relaxed...

Nixon won reelection in 1972. In the months that followed, inflation began to pick up again in response to a variety of forces - domestic wage-and-price pressures, a synchronized international economic boom, crop failures in the Soviet Union, and increases in the price of oil, even prior to the Arab oil embargo.

Nixon...reluctantly reimposed a freeze in June 1973. Government officials were now in the business of setting prices and wages. This time,... the control system was not working. Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.

...Only one segment of the wage-and-price control system was not abolished -- price controls over oil and natural gas. Owing in part to the deep and dark suspicions about conspiracy and monopoly in the energy sector, they were maintained for another several years....

The oil-price-control system established several tiers of oil prices. The prices for domestic production were also held down, in effect forcing domestic producers to subsidize imported oil and providing additional incentives to import oil into the United States."

When the domestic price cap was lifted, USA oil operators were 'dropped back into' an environment where previously uneconomic oil plays were now economic, due to the sudden 100% exposure to market rates for oil.

Lower 48 as a group(excluding Alaska, Prudhoe Bay) peaked about 1970.

High international oil prices were a boon. Yet pickens were slim as production continued to fall...

Suncor had a major maintenance shutdown and an upgrader fire at its oil sands facilities in 2008, so it couldn't step up production to meet demand. The thing is that oil sands production cannot be ramped up on short notice. It takes years to start up a new operation.

Yes it did but by far too little to match excess demand, looking at the EIA production capacity estiamte, it has increased by 0.610 mbpd per year between 2007 and 2009.

Re: Aren't consumption and demand the same thing

No, they are different concepts in economy but they are very often used interchangeably, Demand signifies the ability or the willingness to buy a particular commodity at a given point of time. For instance, kids have a high demand for candies, however candies are not available all the time and consumption is low most of the time but when available, stocks disappear almost immediatly :).

Re: Perhaps your definition of demand is different in that you define it as infrastructure available to burn X barrels per day of oil

Yes, you can see it that way, imagine that oil will go back to $20 a barrel tomorrow for the next 6 months, the resulting surge in consumption would give you an indication of the level of demand that was suppressed (assuming that other exogenous factors stay constant).

Unfortunately, demand is not a truly measurable parameter and does not have any absolute scale associated with it. It is at best inferred. This has always been my problem with economics. I deal with this in my oil depletion modeling by saying that demand is some monotonically increasing stimulus, essentially equivalent to a "greedy" algorithm, and watching perturbations on the output to detect shocks to the system.

If you can get info on demand from rank estimators (qualitative high, medium, low demand, etc) or from proxy quantities then you can include this in the model I would think. The proxy for demand for candy would be how loud the kid screams for candy (measured in decibels), for example.

The fact that we only have this one great unknown of demand makes it the carrot on the stick for us modelers. Hey, its only one unknown, how hard can that be? Never mind all the game theory, Nash equilibrium, and other psychological factors that play into demand.

Recently I was fascinated to learn that the "Austrian School" of economic thought (von Mises, Hayek, et al.) holds the belief that it is foolish to try and mathematically model something as complex and un-quantifiable as human behavior. They eschew econometrics in favor of theories based on deduction:

Methodology is the one area where Austrian economists differ most significantly from other schools of economic thought. Mainstream schools such as the neoclassical economists, the Chicago school of economics, the Keynesians and New Keynesians, adopt mathematical and statistical methods, and focus on induction to construct and test theories; while Austrian economists reject this approach in favor of deduction and logically deduced inferences. Austrian economists stress deduction because deduction, if performed correctly, leads to certain conclusions and inferences that must be true. Though Austrian economists do not discount induction, they hold that it does not assure certainty like deduction. Mainstream economists hold that conclusions that can be reached by pure logical deduction are limited and weak.

Very interesting Jerry. The thought got me thinking about the "future unknown/yet to be discovered" oil/NG reserves some folks "model". Until the latest revelation about the influence others have had on IEA estimates perhaps many thought this was a process that wasn't dominated by the "human behavior" to which you refer. I can offer that any estimates of reserves (past, current and future) is very much dominated by human nature even without outside forces coming to bear.

There are some very skilled analytical thinkers here at TOD who offer great insights. But they generally start with some base numbers offered by geologists and reservoir engineers. But some of our most critical assumptions utilized to initiate the analysis are completely arbitrary. That doesn't mean we should dismiss such modeling out of hand but realize that there exists a huge range of initial condition assumptions.

A very simple but completely accurate example of how we scientists come up with the "facts". There is the drilling prospect A. What's the probability of success? Virtually all such technical analysis begins with such a risk analysis be it drilling or the probability of some undiscovered oil accumulation existing in the world. And how do we scientifically come up with that number? We don't. We just pull a number out of our butt. Yes...we have an experience factor that plays heavily into the process. But that can just as often lead to a very biased and faulty decision. Prospect A looks like 2 similar wells I drilled but didn't work so I give it a low Ps. But another geologist who's drilled two similar prospects that did work gives it a high Ps. Both risk assessments are valid: they are based upon an honest analysis utilizing one's experience. But the both can't be correct. Or can they? Each geologist can present you his reasoning with equal support. Which one would you accept?

Then you get to the less tasteful situation. Geologist B doesn't think Prospect A isn't very good but he hasn't presented a drillable deal to management in two years and feels his job is in jeopardy. So he assigns a high Ps. Why not? If it works he saves his job. If it doesn't he's out the door (or not...geologic failure is often more readily forgiven then the failure to generate). Consider the choice an IEA analyst might face: provide his manger with a number he knows he really can't generate accurately or tell the boss there is no answer to his question. And this doesn't take into account any additional pressure he might feel if he knows his boss already has an answer he wants to see. This is the main reason I try to avoid debating the outcomes (at least on a quantitative basis)of all the different resource models presented on TOD. While we do have a good number of great analysts here their conclusions often hang upon the validity of the initial conditions presented by geoscientists. I've watched honest and smart geoscientist generate vastly different answers to the same data set. We are not mathematicians. Geology is basically an observational science. And what any person observes is very much dominated by their humanity. Ask anyone wrongly convicted of a crime based upon the honest(in their minds) testimony of a eye witness.

That is a very insightful comment, thanks for taking the time to share your experience. The dependence on initial assumptions is spot on. In my readings on system dynamics modeling much the same point is often stressed, namely that a model is really only as good as the assumptions that go into the design of it.

The authors of "The Limits to Growth" took great pains to explicitly state their assumptions for that very reason, and they challenged anyone who disagreed with their analysis to present an alternative model with all initial assumptions also made explicit. Unfortunately that never happened, and they were attacked largely for ideological reasons instead. I think it was Paul Krugman who recently admitted that economists in particular were miffed because the team from MIT didn't ask them first.

I wonder now what an analysis of energy discovery and production based on logical deduction would look like.

You might say that this is my answer to those who cheerfully assert that human ingenuity and technological progress will solve all our problems. For the last 35 years, progress on energy technologies has consistently fallen below expectations.

Where "Limits to Growth" was criticized was for how it treated price-feedbacks. As I understand it, the equations underlying LTG weren't made available until two years after the original publication.

I also heard that no one else was able to duplicate the LTG results as the model was complex in its connectivity. One of the hallmarks of good science is reproducibility and openness, but I would say that the original LTG team was too inscrutable.

As I understand it, the equations underlying LTG weren't made available until two years after the original publication.

That's probably a common misconception. The book "Limits to Growth" was just one of three reports to the Club of Rome, and only ever intended to be a summary of the research project. The 630 page volume titled "Dynamics of Growth in a Finite World" is the extensive report that contains the detailed description of the mathematical model and the research behind it.

For those who didn't want to wait for that third report it was certainly no secret, as Krugman points out, that the model used was based in no small part on the equations published in Jay Forrester's book "World Dynamics".

You could measure investment in infrastructure as a factor. The analogy is someone paying $50,000 for a car will tend to drive it. Chances are the vehicle in question won't be driven 24 hours a day, like a taxi, but it will be driven frequently and persistently- the process is multiplied. Add the cars plus highways, trains, roads, bridges, airports, etc. (quantities) and there is an envelope for fuel use. From the factor, parameters can be set.

I don't know if the exercise is worthwhile. Can a good model be created? Probably, but it's safe to say that from here on in, demand will outstrip the available supply regardless.

Any chance this post could be sent to Energy Secretary Chu and the members of The Obama administration who are tasked with national economic policy. I'd like to send it to members of my local city council but my recent experience with them is that they are too stupid to understand what is so plainly obvious from this post.

My experience with the local City Council, and my suspicion about Sec. Chu, etc., is that they are far from stupid or ignorant about these matters-- they know perfectly well what is going on, and they know that if the bubble isn't kept inflated we are all doomed.

It appears that their hope is to reduce expectations faster than credit and energy supplies evaporate so that a "soft landing" can be achieved, and general social chaos avoided.

It looks to me like they are succeeding pretty well. The "stock market" is up, the Bear Stearns guys got off by a jury of their peers, people are driving to work if they have jobs, or are staying home watching TV if they don't. No sign of unrest out there.

However, now you are getting the economists in a tizzy and there will be a flood of arguments over definitions of terms, and trying to expand the model.

Question:
is not supply also a function of marginal cost of production
i.e. there are fixed and variable costs. If the price is below variable cost, they shut down.

My point is that the current $75-80 price is partially a function of the US dollar decline, and the distortions it causes.

One of the presenters at ASPO was the Scottish investment banker (oil futures trader) who described current market oversupply conditions, which are persisting, yet we have 75-80 price, despite many analysts saying the price should logically crash to 20 to clear the market.

I suggest we have good supply/demand balance now, as reflected in stable price.

I suggest we have only had imbalance (that is greater demand than can be met by immediate supply) very rarely in the past 50 years. Once was in 1973, and once was at the end of 2007 - mid 2008. The incline of the price curve changes dramatically at those times.

You're probably right, I'm not an economist and I don't pretend to be one, most of them would probably pull their hair reading this post. However, I could have used more "neutral" technical terms (like X and Y) to describe what I'm doing but it would have not change the analysis that much, it does not take a Nobel prize in economy to see that the residuals from the nominal models is a good explanatory factor for the oil price increase.

Re: My point is that the current $75-80 price is partially a function of the US dollar decline, and the distortions it causes.

I think it is overstated as a long term factor (it may affects small time scale fluctuations however) and at least not a contributing factor of the same order of magnitude as excess demand.

Re: I suggest we have good supply/demand balance now, as reflected in stable price.

I tend to agree with that, the model above does not take into account GDP contraction which means less business, more unemployment, etc. therefore lesser oil demand. However, you'll see in part 2 that the Non-OECD demand is the elephant in the room.

I would be happy to get the economists in a tizzy. They are the ones that have screwed the pooch by not including resource constraints in their models all these years. What was that theory of substitutability the economists claimed would always save us from the resource problem?

I was recently talking to a well-regarded economist who specializes in econometrics recently and the "big finds" off Brazil was the rationale for ignoring oil depletion as a problem. All the major league economists will eventually have to face up to the fact that all their models are sunk-cost and they will have to come up with something new. They invented the idea of "sunk cost" dog food and now they will have to eat it.

As the noted philosopher Spinoza said "The concept of dog does not bark"

"I would be happy to get the economists in a tizzy. They are the ones that have screwed the pooch by not including resource constraints in their models all these years. What was that theory of substitutability the economists claimed would always save us from the resource problem?"

Thanks for providing such a clear example of the tendency for some people online to paint with an insanely broad brush, and therefore make ridiculous statements.

As I've pointed out many times online, I am an economist, and I've been on the "right" side of energy and environmental debates since day one. So don't stick me in the same pigeonhole with the myopic fools who got it wrong.

And let me fill everyone here in on a little secret: Economists are as upset with you (plural) as you are with them. The endless confusion between "demand", "quantity demanded" (yes, those two are different), and "consumption", are enough to make me break out my bottle of cheap red wine.

And when the talk starts about "is it supply or demand", I want to scream. It's both! Demand alone doesn't dictate prices, nor does supply alone. It's the interaction between the two forces. For a very crude mental model, consider a parachutist. The air resistance and gravity (among other factors) balance to result in a rate of descent. Changing just the force of gravity or just the effective resistance of the parachute will only have a predictable effect if you make the dreaded ceteris paribus ("all other things being equal") assumption. This is where so many people, particularly the doomers, go so wildly wrong: They have no apparent appreciation for the complexity and dynamic nature of markets. That's NOT code for "higher prices will always create the desired supply", but a simple recognition of reality. When market conditions change it kicks off a cascade of changes, including some new supply, some demand destruction, some technological change that creates new substitutes, and so on, that will ultimately result in the market reaching a new equilibrium, if it's left undisturbed by further shocks for long enough. In practice, we never reach a true equilibrium, but tend to orbit around one (think of an electron cloud), with the state of the market constantly jostled by minor changes.

I can't tell you all how many times I'm practically screaming at my monitor over the way many people make ridiculous, linear extrapolations and reach absurd conclusions. There's a term in computer science for that syndrome: GIGO (garbage in, garbage out).

I think I understand, or at least empathize with, your outrage. I feel the same frustration when non-medical people tell me what my job should be.

However, I think it is unhelpful to scream at your monitor.

Writing posts on the OilDrum is more helpful. Even more helpful is to get out and talk to people, protest on street corners, write to the editor of the local paper, maybe even run for City Council.

Fundamentally, the knowledge that professionals of practically all disciplines have worked so hard to obtain is being trivialized and commodified by a giant marketing machine - think "Global Warming" for an example. This is no way to run a democracy. Thinking people -- those who want to solve problems together, rather than merely eliminate the competition -- need to take back the machinery of the state.

The whole rationale behind these economic equilibrium arguments is hotly discussed, not only in economic circles but in computer science circles. I mentioned the idea of game theory in another comment on this thread. These researchers claim that the equilibrium for price wars (and other human processes) may be intractable.

So you essentially have to blame Computer Scientists for usurping the economists' research.

Causal modeling of which Sam is attempting a little bit in this post is also prone to the explosion in states. Say that we had 70 parameters each with a possible outcomes of (low,nominal,high). Trying to find a maximum subject to some constraints in this space would require more calculations than the number of atoms in the universe (i.e. 703).

That is also elementary computer science and it explains why we often times concentrate on toy problems -- those are the only tractable ones. Of course there are other ways to make problems tractable, and those come under the umbrella of statistical mechanics and complexity theory. I have written up a TOD post on that subject and it is in the queue.

Game theory is a curious area. I was talking to an economist that uses game theory in his research about the article you mentioned and he suggested that game theory is normative rather than descriptive (i.e. "this is the way people should behave" rather than "this is the way people actually behave").

One of the "positive" aspects of the "economic crisis" is that critiques of mainstream economics that were dismissed quietly as heresy a few years ago are being aired again (see Mark Thoma's blog). These come from both theoretical perspectives (arcane issues around "aggregation" and whether economies are ever in "equilibrium") and recent findings within experimental/behavioral economics that contradict the rational agent model. Whether these discussions have any long term implications for either the discipline or the curriculum for freshmen economics courses remains to be seen.

Interesting. Normative is also the province of software languages, where you are restricted in what you can accomplish. So what happens if in the future all price wars are settled by computers, which are limited by algorithms written by this same set of normative rules? It makes you wonder how the rational arguments will change. If they used the same software, say the Bloomberg machines, then a true equilibrium can be predicted just by understanding how the software works.

The problem is that some equilibrium may exist whereas one person has all the money :)

Actually, feudalism, where an extremely small set of the population own absolutely everything including everyone else, has had longer periods of stability in history than the relatively short periods in western history where income was (by all historical standards) fairly evenly distributed.

If there is one area where modern economics certainly fails in the application, it is in the interaction between economic and political power, where economic advantage is used to secure political advantage, which further entrenches economic advantage. Usually economists seem to simply ignore this,.

Actually, feudalism, where an extremely small set of the population own absolutely everything including everyone else, has had longer periods of stability in history than the relatively short periods in western history where income was (by all historical standards) fairly evenly distributed.

True enough but that was before the cat got out of the bag. We may even eventually revert to such a stable system, however I don't think it would fly right now that all the serfs have grown accustomed to their comforts.

Good to see you are still reading TOD. I appreciate your nuanced statements in defense of economics despite the real worries of a depleting, finite resource such as oil. My mindset has always been to "embrace the complexity" as a way to understand the world. Many people don't seem capable of that approach - not a slam we are all just wired differently.

So were you screaming at your monitor about Sam's post or did he do a pretty good job of describing the drivers of supply, consumption and price of oil for us lay people?

I have a post in the TOD queue that includes that same phrase "embrace the complexity". I guess it is a bit of a catch-phrase, yet the whole philosophy behind coming up with a concept such as entropy is as a way of dealing with complexity and uncertainty. As a way of understanding the world, I would certainly agree with you.

For example, many of the Black Swan "fat-tail" models that are currently displacing the "Normal" statistics models derive from entropic considerations. I can usually detect the entropy in certain graphs based on what the underlying mechanisms are, whether it be dispersion or some other randomized phenomena.

In practice, we never reach a true equilibrium, but tend to orbit around one (think of an electron cloud), with the state of the market constantly jostled by minor changes.

As a physical scientist, ridiculous statements such as this make me want to break out my bottle of the good stuff. Back away from the physical analogies and nobody gets hurt.

Given that EIA and IEA have essentially been "linearly extrapolating" GDP growth to predict future energy demand, Sam's approach appears reasonable. Would you be willing to recast Sam's observations in Figure 2 in the words of an economist?

Not only physical scientists would question this, but statisticians as well.

The "orbiting around a cloud" analogy is essentially the old Normal statistics with a narrow standard deviation approach that people like Taleb are discrediting. Dig deeper and you find lots of phenomena that don't follow Normal statistics.

The obvious one in my mind is what happens if multiple economies start to appear due to ELM considerations. All these economies will take on more dispersed trajectories depending on their own individual resource constraints. There is no true equilibrium here in the sense of a global economic picture, only an aggregate of paths.

LouGrinzo,If I had seen your post before I put mine up I would have left the clarifications of misinterpreted basics up to you.

Sometimes I am suprised that we are ONLY as confused as we are.

I will bet a hundred bucks that if you stop a hundred college students at random on thier way to a football game at any really large university that not over fifty percent of them can define "function "in the mathematical sense.

Thanks for providing such a clear example of the tendency for some people online to paint with an insanely broad brush, and therefore make ridiculous statements.

The Jay Hanson articles that are posted here typically include ridiculous claims about what economists supposedly believe. I'm convinced that he is being intentionally inflammatory and no longer bother reading his writings. If he can't get that much right, what reason do I have to believe he gets anything else right either?

Beyond that, I have mixed feelings about the public treatment of economists. I would prefer to see more humility on the part of practitioners of the discipline, given that the much of the theory consists of a series of conjectures without substantial empirical support. Having said that, there have been instances of articles on these boards where non-economists have used economic concepts (e.g. GDP) without understanding these concepts sufficiently to do coherent analysis.

I would suggest that commenting broadly on conventional economics does not (and should not) hurt credibility too much. Its all a bit of a confidence game as you have little idea of whether the person pushing some idea or data doesn't have a hidden agenda. Theory is irrelevant if their goal is to make money (perhaps at your expense). There is so much of this going on now, and with the realization that it boils down to game theory, means that we shouldn't take it too seriously. That's why we can slam economists -- and financial quants -- hard. They should know how to take it.

In contrast, if I were to get something as fundamentally simple as resource depletion wrong, I would have to question my own credibility.

As I've pointed out many times online, I am an economist, and I've been on the "right" side of energy and environmental debates since day one. So don't stick me in the same pigeonhole with the myopic fools who got it wrong.

Lou, if the shoe don't fit then don't wear it. Anyway look on the bright side at least you're not a lawyer ;-)

BTW there is someone in my extended family who has a PhD in economics and works for the IMF, unfortunately he also happens to fit the stereotype. Ces't la vie.

"This is where so many people, particularly the doomers, go so wildly wrong: They have no apparent appreciation for the complexity and dynamic nature of markets. That's NOT code for "higher prices will always create the desired supply", but a simple recognition of reality. When market conditions change it kicks off a cascade of changes, including some new supply, some demand destruction, some technological change that creates new substitutes, and so on, that will ultimately result in the market reaching a new equilibrium, if it's left undisturbed by further shocks for long enough."

This sounds good until you come to the word "if" in the last sentence. That is one hell of a big "if" given what we are facing. At some level of stress, the "cascade of changes" model has to break down.

I think many doomers do appreciate the complexity and dynamic nature of markets. They have evaluated the future stresses (peak oil, climate change, greed) and concluded the markets won't survive.

Agreed. What many economists seem to define away is the possibility that there is a set of circumstances and forces that the system can't handle.

We had a simple example here in the Bay Area when a truck driver drove off the Bay Bridge this week and died.

The set of circumstances that caused the accident was that he was turning at too great a speed with a load of pears that may have shifted during the turn.

Had he driven more slowly or the load was smaller or the corner not as sharp or perhaps a little less of all the variables and the accident would not have occurred.

In our case, we have an economic system that demands growth on a finite planet (a sharp curve coming up when the system becomes even more strained) and a population that is demanding that growth returns (a driver stepping on the gas).

Given this set of circumstances, is there any way for this to end other than collapse?

Given this set of circumstances, is there any way for this to end other than collapse?

I think we may have some analogs, which have happened during wartime. Sometimes a city or country is blockaded or cut off from supplies. How many of these (not directly involved in hostilities) have broken down into a mad max freeforall? I think the answer is very few. A lot of societies have faced declines more severe than I think post PO declines are going to be, and remained mostly intact. The only thing going against us, is they has an external enemy to blame, so the tendency was to work together to thwart the intentions of some evil enemy. In our case, the thing to fear is the blame game trying to find internal enemies to blame. In societies where that doesn't become an important part of the social/political dynamic, I think the transition will go OK.

"The only thing going against us, is they has an external enemy to blame, so the tendency was to work together to thwart the intentions of some evil enemy." Posted by Enemy of State

They also would have the advantage of being aware that the situation would likely persist for a relatively short duration. Within a few years at most, the embargoer/invader will either be repulsed, and the embargo lifted, or he will capture and occupy the place, after which at least basic supplies would again be available, even if at a reduced level. Resource depletion, however marches on relentlessly and permanently, only ending when there is finally no more of a particular resource that is available to be "depleted."

I, for one, would not mind if you repeatedly defined demand, consumption, supply, etc. every time they were misused, much as Jeffrey does about ELM every time there is a comment about production estimates.

Well, great! There's an economist who actually includes reality in their thinking rather than believing blindly in the ever-supplying invisible hand. Thus, we should trust economics!

I think not. Few disciplines have done as much to mislead the global "we" than economics.

Most are idiots of their own construction. I will stand by that statement without even a hint of humility. Thank god a few Austrian School people are out there - though even they get it wrong with their love of markets.

You'd think someone would point out models created to model a period of unprecedented plenty don't reflect reality. How can so many people be so damned blind?

At the end of the day, I will (relatively) trust any field in aggregate. Geologists, physicists, physicians, etc. - at least at the theoretical level, if not the practice of their arts.

But economists? They are absurd until proven rational. This is known as being hung on one's own petard.

What was that theory of substitutability the economists claimed would always save us from the resource problem?

Well, as far as I can tell, it's some combination of substitution and technological improvement that the economists think will save us. The premise of substitution itself is simply that at some point, there will be a price at which it will make sense to switch to a "backstop" technology. The added assumption is that research and development will eventually make that technology affordable.

I'm not sure that the economists are alone in this belief. My undergraduate degree was in physics. From what I gather in the limited conversations I've had about oil depletion with former classmates from that period, they don't seem to be particularly concerned, apparently mostly believing that some alternative energy source will allow a cleaner version of BAU.

The first half illustrates that the supply/demand divergence appears real. The monthly model was parametrically fit to demonstrate that the divergence from extrapolated trends could not be due to noise. You could almost see this from the underlying periodicity but it does show up clearly when a model is applied.

The second half of the post discusses what relationships are key to the high prices. The approach taken is to (naively and unbiased) assume that each indicator has some causal connection to every other indicator. Then the Tetrad software is able to reduce the interconnections to only those edges that show a high correlation. (The big if in all this is that correlation implies causation, but that is OK for experimentation) My question is whether the time delays between the various quantities is taken into account. In other words is this a transient kind of analysis or is it set up as an equilibrium model? This separates out causation as a temporal phenomenon or as pure feedback between the elements leading to an equilibrium.

I ask this because the first half of your post has a very sophisticated temporal model (down to the month) while the second half does not discuss the time aspects.

It also occurred to me that this kind of approach could be used to interpret the causality between CO2 and temperatures in climate change studies. Economics unfortunately has all the psychological factors associated with it, while physics should have only concrete physical causal relationships.

I quickly looked at the Tetrad site and found no example case studies. Impressive that you were able to figure out this software w/o the benefit of any concrete example or demos.

I'm still in my learning curve with the Tetrad software, I encourage you to play with it, the interface is very intuitive and it's launched as a neat remote java application. It implements various causal search algorithms that are reffering to a fairly large litterature, the one I used here is the Markov Blanket Search algorithm akin to an unsupervised Bayesian network construction using price as the target variable. I'm not 100% sure this particular algorithm is performing a preliminary vectorial AR analysis (VAR). I initially used a Granger-causation analysis based on a VAR analysis of the data over various times lags, the issue here is the short sample size (only 50 months) which makes the VAR estimation very noisy in particular when the proper model order is established with a BIC criterion.

Here's the digg, reddit and SU links for this post (we appreciate your helping us spread our work around, both in this post and any of our other work--if you want to submit something yourself to another site, etc., that isn't already here--feel free, just leave it as a reply to this comment, please so folks can find it.):

Thank you for this post! The Tetrad IV link alone was worth the price of admission (reading), not to mention the other stuf:

Quickly:

- A(k) in your sum series is... ?

- 2001 as cut-off point was derived from D(t) trend break-down ?

- Fig 5. Why 2002? Why not 2003/2004 when the excess capacity and prices broke away from their previous levels (i.e. what is your criteria)?

- Conclusion 1.2: OPEC spare capacity. Unresponsive for now. Just as there was a trend between 2002-2008, there could be a new trend emerging. at least that's how many energy economists view the markets (e.g. OIES): trend equilibrium, disequilibrium, trend-formation, new equilibrium, repeat.

- Based on 1.2. one would want to ask the question: Why? Does 'artificial demand' (i.e. speculation) contribute to this at all? If so, the move from WTI to Argus ASCI might show something come next year)

- Conclusion 3: can the marginal cost growth really be roughly linear? This doesn't play well against the upstream cost curves I've seen thrown around by CERA and Goldman. What was your fit for the linear regression?

- Conclusion 6: Where does the -3Mbpd demand reduction come from? I can eyeball roughly a drop of that magnitude in consumption from Fig 2, but demand drop? Is it the Jun-08 to end of recovery (yellow dotted line) diff in Fig 4? How do you differentiate between price related demand adjustment (ongoing since 2002 till ? in your graph) from financial crises induced demand adjustment? Is it just based on falling vs rising prices trend? Or some price level cut-off? Maybe I'm thick, but I can't deduce this with certainty.

And now somewhat off-topic:

As for the argument "Unfortunately, the only way structural changes in demand could be estimated is if the oil prices of tomorrow would go back to $20 a barrel for a few years within a pro-growth and healthy business environment". I think the 'peak demand' argument from economists is an exercise in über-hubris.

What we might see then is new demand adjustment (or demand creation) that would mask any possible level of earlier demand destruction or negative demand adjustment (temporal).

In short, what I'm trying to argue - and I could be wrong - is that there is *no way* to know. It's just economical philosophizing : maybe destruction, maybe adjustment, maybe peak, maybe not.

In the end, it hardly matters, if it rebounds and whether we call it demand creation, demand re-adjustment or whatnot. It rebounded, demand went up. Price went up. Elasticity might be slightly different this time around, but probably not by much. Time would tell. I assume we agree on this last bit (that it doesn't matter that much).

I fully agree on the idea that if a true demand peak would happen, your test would be the arbiter on the demand peaking. However, it's a fairly unprovable argument from economists, as oil surely would come back in vogue if the price fell low enough comparative to alternatives. Money goes where the best opportunities lie - it's all relative to the price.

The whole demand peaking is a function of relative costs. To say demand has peaked for good includes the assumption that the forecaster knows the relative price levels of oil and it's substitutes from here to eternity. A bold claim, I might say (hence the claim about overconfidence).

Again, this is not against your model - I find the demand peaking a total diversion in the discussion. We'll know for sure in maybe 20-30 years. Not today. Forecasting it is even more futile than trying to predict the oil price alone to 2040, which is difficult enough as it is.

There might not be enough information to reconstruct the scenario, but the temporary demand destruction periods from the 1970's and 1980's might benefit from a historical revisiting using this approach. The contractions were of that same order back then.

prices were fairly stable before 2001 and significant deviations from the model after 2001.

Fig 5. Why 2002? Why not 2003/2004 when the excess capacity and prices broke away from their previous levels (i.e. what is your criteria)?

Depends on your criterion, start of the first ramping-up in prices was mine.

Conclusion 1.2: OPEC spare capacity. Unresponsive for now. Just as there was a trend between 2002-2008, there could be a new trend emerging. at least that's how many energy economists view the markets (e.g. OIES): trend equilibrium, disequilibrium, trend-formation, new equilibrium, repeat.

Possible but after almost 5 years of sustained high oil prices, no significant increase in production capacity makes you wonder.

Based on 1.2. one would want to ask the question: Why? Does 'artificial demand' (i.e. speculation) contribute to this at all? If so, the move from WTI to Argus ASCI might show something come next year)

With no data about speculative activities it is hard to give a definitive answer, studies about the future market are showing that speculators are trend followers (i.e. they change positions after price changes).

Conclusion 3: can the marginal cost growth really be roughly linear? This doesn't play well against the upstream cost curves I've seen thrown around by CERA and Goldman. What was your fit for the linear regression?

It's a rough approximation, an exponential fit would have been an overkill here I think.

Conclusion 6: Where does the -3Mbpd demand reduction come from? I can eyeball roughly a drop of that magnitude in consumption from Fig 2, but demand drop? Is it the Jun-08 to end of recovery (yellow dotted line) diff in Fig 4? How do you differentiate between price related demand adjustment (ongoing since 2002 till ? in your graph) from financial crises induced demand adjustment? Is it just based on falling vs rising prices trend? Or some price level cut-off? Maybe I'm thick, but I can't deduce this with certainty.

That's very speculative at that point I think that business slowdown due to poor credit availability and rising unemployment has temporarily reduced demand by a significant amount (probably around 6 mbpd), meanwhile consumption has risen for a few mbpd for the last few months (seasonal fluctuation).

Of course, I have no idea how they pulled the data together, so TIFWIW.

Now that I look at them again, it's difficult to say anything certain about the cost escalation trend, just by looking at the above graphs. It could well be linear increase for now and perhaps levelling off when a big enough resource base is utilized for long enough and costs get sunk.

Interesting stuff, although I think most of the readers (myself included) are a bit lost with the mathematical jargon.
I think a useful concept regarding the question of attribution (demand or supply) would be to estimate the elasticity of each separately, i.e. as a function of price, how does demand vary. And as a function of price, how does supply vary. Ignoring for now the time lags involved any imbalance should be met by some of each factor, and clearly the more elastic variable will change the most. I suspect that the price has changed (and probably will change enough), that using the log of the price rather than price would work better.

Then we have the issue for a given step function change in price (or log price) how does demand vary with time. Presumably there is a small amount of instantaneous elasticity, as people do things like drive slower and consoladate trips. Other adjustments such as moving closer to work, finding car pool partners, purchasing a more efficient vehicle take longer. Still other adjustment mechanisms might have even longer time delays -demand for electric cars is there (say), but won't satisfied until first battery research creates good batteries, then production can be built, then inventrory accumulates. So I suspect that the temporal elasticity of demand probably has some important time varying characteristics. And a similar argument could be made for supply.

Great post, Sam!
The "Peak Demand" argument has needed an analysis and an intelligent response for a while.

For me, the argument intuitively makes no sense because, absent substantial energy efficiency gains, a "Growth Economy" must demand increased energy inputs. And there have been NO significant energy efficiency gains of which I am aware. We know that hybrid cars, which can slash liquid fuels consumption for transportation, still only represent, what, less than 2% of the vehicle fleet. And although there have been some energy efficiency gains for industry over the last twenty-five years, it's hard to see where additional, order of magnitude, gains have mysteriously come from over just the past two years other than thru production collapse.

I feel there is a disingenuousness and even a mendacity to the whole "Peak Demand" thesis.

I have problems with quantifying demand in terms of precise metric, yet you can still try to do polling or some other experiment to place an enumerated value to demand, such as "high", "medium", or "low". Or you can do this at various price points. In that case you can still conceivably do the causal effects analysis that Sam has described. (You also have to assume that these do not get redefined over time I suppose)

I say this because the causal effects analysis does not attempt to figure out the absolute strength of the effects, but which ones are strongest in rank.

Mac, "there are no magic bullets available in the short term." I wonder. like you i read the post, did not study the mathematics but assume since it is here it must be worthy of thought. Found myself in general agreement, looked at the comments. then your quote above tickled my fancy. If one tunes into the noise going on out there in the economy its maybe telling us something. One of the best things i think it is telling us that the economic system we are operating under, and which the fundamental assumptions of this elegantly built model is based, might be adjustable. Such adjustments to regulations that put some constraints on irrational desires being satiated by conspicuous consumption have the capacity to greatly reduce consumption. i believe regulations effecting energy use al all levels need to be implemented. Witnessing the fight being put up in many areas, ie. cap and trade, health care, insurance, banks, financial to mention just a few. The growth oriented nature of these industries is clear and placing any constraints on their ability to grow is proving extremely difficult. Listen to fox news an talk radio. what are the most frequently used phrases. Liberty and Freedom. The social and economic brand of conservatism being practiced represents real threats to the future of our world. Think it might be about time for some serious thinking about some to the basic assumptions inherent in this very valuable contribution to understanding how one aspect of this overall subject is acting. No, your correct. The effort is proving too difficult for our current political system. There is no magic bullet.

Figure 5 in my opinion shows perfectly the fact that OPEC was unable to match increasing demand with spare capacity after 2002. The difference between the red line and the green line says it all. Once spare capacity could no longer support higher flows at cheap prices, demand was forced downward.

One must wonder how many barrels a day the World economy would be consuming if cheap oil had continued to flow at every higher rates after 2002. Would there have been an economic collapse in July 08?

IMO, the high oil price in the face of lowered demand this year is a function of the devalued dollar. Caused by this new admin's penchant for printing money. Other hard assets like gold have also increased in value. The same thing happened during the Carter administration's "stagflation".

The "Peak Demand" theory is also more plausible than "Peak Oil" because of:

1.The long term shift in employment to Asia from the US and the EU.
2. More fuel efficient vehicles - especially hybrid cars, trucks, and busses.
3. Increasing volumes of biofuel.
4. Increasing use of EVs (over 20 million in China this year).

Explain then Conservationist why OPEC would not have taken advantage of higher oil prices between 2002 & 2008, if they had the spare capacity to do so.

And remember Carter has nothing to do with peak oil. In fact he tried in vain to get the attention of those in DC to understand the impending energy crisis we would face if we did not proceed then with a green revolution. It was your beloved Reagen that squelched it by removing the tax cuts for renewables and pulled the solar panels off of the White House roof.

The OPEC position at the time was that there was no shortage of oil. That the price spike was from speculation, and there was no need to increase supplies. In fact I do not recall ANY shortages at the time except in Matt Simmons' imagination.

And it was my beloved Bush that made the US number one in the world in biofuel and wind power production. And he also extended the solar tax credit to utilities. Why couldn't Carter do that?

I lined up for hours week after week with my father waiting for rationed gas. There were price controls and a 3 color flag system in many states to demonstrate who could purchase fuel. Where I lived (San Diego), there was rationing.

Conservationist, you're better at avoiding a question than a politician. You didn't even read this article, did you? Go back and read it, and you'll see he explains that increased oil prices reduced demand by 3 mbd. You actually don't understand that by supplying more oil the price would have gone down? It's because they didn't have anymore spare capacity the price kept rising. That's basic economic fundamentals. I can't teach you this stuff. To be on here and argue your point, you need to have taken at least college level econ. 101 course, and that's a minimal scholastic foundation. Preferably you also need to be versed in 102. Those are undergraduate courses.

Beloved Bush - yech! Biofuels are a sham and Bush should be ashamed of himself for pretending they were an answer to reduced oil supply. They are net energy loser.

Why did Reagen eliminate the tax cuts for renewables and pull the solar panels off the roof of the White House? You start answering my questions and I'll answer yours.

It didn't increase immediately at 30 something a barrel because the economy had just collapsed! Yes, it is that simple. Supply and demand determines price, especially over a period of time from 2002-2008. There was plenty of time in that 6 year period for OPEC to supply more oil to take further advantage of high prices. Are you saying that they had the product but just decided not to make more money? Who does that? Look at figure 5 from the article. Look at the red line, then look at the line for oil price. If supply had gone up then price would have stayed down.

Biofuels is a sham. It takes more energy to produce ethanol from corn than it produces. It's net energy negative. It also takes away from food for people. That will probably become a huge problem worldwide in the not too distant future.

The tax breaks Carter set in place for renewables was eliminated by Reagen. I know, because I remember the report on the 5 o'clock news at the time. If you have information to the contrary, please provide a link.

Yes OPEC could have pumped more oil, but there was no more demand than what they were already supplying. If they did pump more oil, they would have had to figure out some way to store it. The oil price is not only affected by physical supply and demand, but also by speculators. Investors who buy the contract only because they think the price will go up. Some $60 billion went into commodities speculation in early 2008. They can also buy with as little as 5% margin, which greatly amplifies the price swing. There's a discussion about what happened here:

And I don't see how growing corn for ethanol "takes away from food for people". If there were no ethanol plants buying the corn, then farmers wouldn't have grown it. I suppose you think the farmers would have just given the corn away to poor countries. lol

I lived through the malaise, stagflation of the Carter years. The economy under Reagan was much better, and the numbers prove it. Just like the economy was better under Bush than it is now under Obama.

It is well to drive a stake through the heart of 'peak demand'. Dumbest rationalization, yet.

You should read that quote from a post by Steve from Virginia, just below our thread. Re: OPEC, You never looked at figure 5 did you? You don't understand supply and demand. That's ok, some people don't. We'll just have to move on and let you figure that on out for yourself some day.

If you increase the cost of food as these articles indicate, then you reduce the amount of food lower income families can purchase.

Here is a quote from one of those articles:

We are witnessing the beginning of one of the great tragedies of history. The United States, in a misguided effort to reduce its oil insecurity by converting grain into fuel for cars, is generating global food insecurity on a scale never seen before.

The world is facing the most severe food price inflation in history as grain and soybean prices climb to all-time highs. Wheat trading on the Chicago Board of Trade on December 17th breached the $10 per bushel level for the first time ever. In mid-January, corn was trading over $5 per bushel, close to its historic high. And on January 11th, soybeans traded at $13.42 per bushel, the highest price ever recorded. All these prices are double those of a year or two ago.

Apparently Conservationist, you weren't on TOD about a year and a half ago, but ethanol took a real hard beating. You might get embarrassed if you try to claim the virtues of ethanol on this board. I'm sure I'm not the only one that will bring that fact to your attention.

Unfortunately, there's a lot of misinformation that gets posted on TOD. "Group think" really doesn't prove anything. Fortunately this site does seem to allow all points of view. I'm sure you could find a zillion articles reporting how "bad" corn ethanol is, but let's just look at your above quote and use a little logic. You notice the article mentions the wheat price increases which was true. The trouble is, you don't use wheat to make corn ethanol. So how could ethanol cause the price of wheat to increase? Lots of commodities increased in early 2008 including the price of oil. Again this was from speculation, not corn ethanol production. Corn ethanol production has increased this year, yet corn prices are lower than the peak prices last year. This proves ethanol production was not the cause of last years price spike.

Ethanol, whether you look at it as a panacea like you are, or if you see the negative side as I do, it will never replace enough oil to replace depleting crude in the not too distant future. It will be a really bad thing in developing countries where farmers will make more for the crops they grow for fuel, than they will for crops made for food. All that palm oil for biofuels will mean a lot of people will slowly starve from not enough calories.

I think we need to agree to disagree on this point. Let's let this thread go, before we bore everyone on this board.

I disagree with the conclusion that sluggish supply growth caused the
price rise because it implies that more rapid supply growth would have
avoided a price crash.
Supposing supply growth was much higher in 2004, then the price of oil would have declined and future oil projects would have been cancelled.
In fact oil production by Russia has been quite strong in the last decade.

According to Say's law, 'supply[surplus] creates its own demand'--in this case a new demand in the non-OECD.

I don't know if it is an economic law but the converse of Say's Law might be 'a deficency[scarcity] kills demand' aka demand destruction.

In 2007 some people assumed that based on geology oil prices will move higher and other people, let's call them the mob, watching the price rise began a buying frenzy which lead to a glut in Oil Futures. Then seeing that there were few new buyers, the market contracted and because the future market is basically leaverage the house of cards came down.

OECD oil demand is down because the world economy tanked and it is likely that people and governments are looking for ways to reduce their oil dependency.

Say's Law also amounts to "use up whatever you can find". If there is any utility to the resource it will get used. If we find less, we use less.

At least historically look at the way this has played out. When we had the huge reservoirs to draw from, oil was used in all sorts of ridiculously wasteful applications, such as spraying down dusty parking lots and heating open air venues. I don't see much how demand played into it, as it got used because it was cheap enough and it was available.

In this case peak demand seems no different than peak production.

Things have changed only marginally since that time, IMO. Less waste but only in scale.

Daniel Ahn (LCM) agrees in his prognosis with your view, with the exception that he also shares the view that spare capacity reduction helped to drive up the prices from 2003 to 2008.

According to Ahn, a new oil demand reality is likely to set in, with at least temporarily peaked OECD aggregate demand. However he also suggests trending oil price decrease. Yet, his analysis only covers a time frame some years after the price break. We know what happened after the previous price spike, when demand adjusted and finally the economies started growing again and after oil had become much cheaper.

OPEC's own models support the "peak OECD demand" conclusion in WOO 2009. Interim demand for OECD flat till about 2013, and will not increase by 2030. Sure, they are all projections and possibly politically slanted as such - although to an interesting direction in this case.

Further, ENI's Leonardo Maugeri comes to the same conclusion about OECD demand peak in his recent long analysis about the recent oil price rise and financial crash (recommended reading, btw). His argument is based on policy reaction to oil price rises and resulting structural destruction in demand, instead of mere temporal adjustment. This time he thinks it will also affect the US and not just Europe.

My take is this. For now, OECD demand has highly likely peaked. But to say it's a final peak is stretching the logic. Nobody can know with any degree of certainty how the price/demand/supply/spare capacity function will play out. Or how fast substitutes, demand reduction policies and infrastructure changes come about. Or how economy rebounds.

It's quite curious that the people who say that the maximum theoretical (geologically limited) supply flow canNOT be modelled, yet happily model away total demand, which is based on price AND supply AND spare capacity AND costs AND... (fill in additional factors).

That looks like a serious case of base rate fallacy to me.

Of course, if demand peakers assume that price will keep rising regardless of demand growth keeping down any rebound effects, then to me it looks like they are implicitly assuming peak net oil flows or at least saying that prices will remain high for a very, very long time for unknown reason X, so that demand destruction on permanent basis is possible. Remember, we know from previous studies that price spikes don't help that much in destroying demand, as demand rebounds when prices drop. Long term elevated price levels are required for permanent demand destruction.

As for the Tulip comparison, it would have been apt, if oil was 100% discretionary pleasure commodity like tulips were. But it is not and as such, structural comparisons about speculation break down after any assumed speculative level has been cleaned off the markets and the inelastic demand remains are just not very accurate. What's the inelastic demand part in tulips?

Thank you so much for this post, and especially for putting up that chart. It exactly illustrates something I have mentioned several times before on TOD, an artifact of the way the oil industry works, something of which some here may not be aware.

When inventories are low, then concerns about maintaining minimum operating levels in things such as pipelines start to come into play, and prices go way up - regardless of demand.

When inventories are high, then the concern becomes finding room for the stuff, and prices go way down - regardless of demand.

It is only when inventories are in the mid-range between those two extremes that prices become strongly sensitive to changes in demand.

Furthermore, "oil" is not a single commodity, there are different, not completely interchangeable grades. While the oil industry and the oil market are mostly globalized, they are not completely so. Thus it is possible to have low inventories in some places and high inventories in others. You also have a market that is increasingly dominated by NOCs that are not always operating solely from a motive of profit maximization, and of large national consumers like China that are not always operating solely from a motive of short-term cost minimization; in other words, neither suppliers nor consumers are always operating in exactly the way that the economist's "rational man" hypothesis would expect.

This is a far more complex reality than what is usually addressed in the Econ 101 textbooks (which is all the economics that many of the readers here have ever studied). Perhaps it can still be modeled, but it is going to have to be a much more complex model, and maybe a less intuitive one.

As for the Tulip comparison, it would have been apt, if oil was 100% discretionary pleasure commodity like tulips were. But it is not and as such, structural comparisons about speculation break down after any assumed speculative level has been cleaned off the markets and the inelastic demand remains are just not very accurate. What's the inelastic demand part in tulips?

For rich OECD, oil is quite cheap, even a poor Westerner will spend less than 5% of his annual income on oil so marginally I think is elastic but
when prices get high it's totally inelastic (needs some kind of elasticity L-curve, not a straight line).

a few short months ago, the amount of oil in storage was somewhere in the range of 60 days oecd consumption, about 5 days above normal. i think this equated to 250 million barrels. we havent heard much about that lately.

250 million barrels doesnt sound like much, but if consumption exceeded supply by 1 million bpd, this would take about 8 months to deplete to normal.

Very informative and useful, thank you. The comments have also been useful. It is well to drive a stake through the heart of 'peak demand'. Dumbest rationalization, yet.

Determining appropriate price levels or matching price levels to models/curves is probably futile. There are too many factors and inputs.

- The effect of oil in storage and trading between shippers/refiners/ and speculators holding physical crude. There seems to be a year's supply of 1 mbpd spare capacity in storage or floating in tankers.

- The trading of oil on the different futures exchanges. Futures trading has taken on a life of its own. With the increase in price has come an increase in market participants. Large long positions equal large exchange short positions, with accompanying short squeezes and margin calls. All this adds to volatility.

- The contradictory demand for cash dollars by energy producers on one hand and by finance on the other. There is a more or less fixed pool of available dollars at any given time. A contest has developed to obtain these dollars. Producers can grab dollars by raising the price of oil, finance can grab dollars by raising interest rates. The interplay between oil, dollars and lending/borrowing effects prices - largely driving them up.

- Market functions have been effected by the large cash drains on markets themselves. It may be that oil prices may never see $148. Why, because nobody has enough money left to afford that price level.

- Market manipulation. OPEC has stated that prices much over $80 a barrel are damaging to the world's economy. Watch gold prices skyrocket while oil holds at $80 a barrel. Is this market being manipulated? Looks like it ...

- Tension between oil 'hawks' such as Russia and Venezuela which desire prices as high as the market will bear, the other OPEC oil 'doves' such as Kuwait and KSA which do not, as well as non- OPEC suppliers which have historically kept prices low to facilitate commerce (the benefits of commerce being greater than the actual returns on oil sold). The shift post- 1999, when the North Sea fields peaked and 'Western' producers became unable to use production to lower costs represented a tectonic shift in the oil markets. The balance of trading power switched from consumers toward producers who have gained more and more power to set prices and make them stick. This is the real equilibrium story. The only way for consumers to regain market equilibrium vis. sellers/producers is to conserve sharply. There is no other way, since new, large supplies are not likely to materialize.

All these and more interact to make life interesting for the curious- minded.

By definition, supply is the amount of product that a producer is willing and able to sell at a specified price, while demand is the amount of product that a buyer is willing and able to buy at a specified price.

Without changes in willingness or ability, the relationships between price and supplied amount, and price and demanded amount, can be thought of as invertible (two-way) functions. That is, price as a function of supplied or demanded amount, or supplied/demanded amount as a function of price. Mathematically, this simply means these are monotonic: only increasing or decreasing. Generally, supplied amount increases with price, while demanded amount decreases with price (it would be a bit odd if demand would go up with a higher price, all else being unchanged). Price and produced/consumed amount is then simply where these two relationships cross.

Demand can become saturated when supply is very high. That is, if amount demanded is inelastic, or resistant to increase, with decreasing price. In my understanding of this post, that is the basis for the "excess demand" calculation. Assuming that $20/barrel is a low price leads to the assumption that demand was generally saturated (at least within the context of available appetites for oil). I think this approach to estimating demand that would exist at low oil prices is sound, and clearly shows the trend that OECD economies would have followed had nothing changed in willingness/ability of supply or demand.

The reason I point out the two-way functional relationship is because this concept can help interpret some dynamics. If supply decreases, prices will increase, leading to decreased amount produced/consumed. If demand decreases, amount consumed will decrease, leading to a decrease in price. If there are time lags involved in reaching the new price/amount equilibrium, the system may overshoot due to temporary shortages/gluts that may occur. And of course, this complex system changes continuously.

So how does willingness or ability of supply or demand change? Demand willingness can go down, for example, because of substitution (e.g. alternative energy) or efficiency, where people won't pay the same price for an amount of oil. This is the flawed basis of the peak demand argument, because it lacks the support of observed substitution/efficiency. Demand ability can go down, for example, because of recession: people without jobs cannot afford the same amount of oil at a given price, and reduced business will reduce oil needs. Supply willingness can go down - this is part the basis of the export land model. Supply ability can clearly go down (geologic predicaments).

The dependencies between our economy and oil mean that supply decreases will likely lead to recession (or worse) because lower supply means higher prices and/or lower amount produced/consumed. So, the downhill slide post-peak will likely lead to an alternating sequence of downward steps in supply and demand functions. Trying to pin cause/effect to these steps becomes a chicken and egg argument. If one starts with a supply decrease followed by a demand decrease, one would interpret first an increase in price and decrease in amount produced/consumed, followed by a decrease in price and further decrease in amount produced/consumed. If one starts with a demand decrease followed by a supply decrease, one would interpret a decrease in price and decrease in amount produced/consumed, followed by an increase in price and further decrease in amount produced/consumed. Either way, amount produced/consumed goes down, but the degree to which price goes up/down will depend on the exact shape of the supply and demand functions, and how big the post-peak supply contractions are relative to the economic demand destructions.

If the economy continues to tank, it might be a reality for a short time in the rich countries but as soon as the excess fat is trimmed off consumption it will get progressively harder to make further cuts.

One of my nieghbors has a very nice fishing boat that between the boat and the truck he pulls it with can easily use up to a hundred and fifty gallons in a weekend.Two years ago he took it out once or twice a month.This year he took it out once or twice as his business is doing poorly..In one of the earlier crunches it was said that you can turn off half the lights only once.He has done about all he can do to reduce his consumption-millions of others are probably already in the same situation.

In the meantime depletion like rust never rests.It won't be long until prices are rising in spite of declining consumption.

I don't believe anyone has made a realistic case for consumption being able to decline as fast as production is likely to decline-while at the same time having a steady or expanding economy.

I do believe it is possible to have a robust economy on a lot less oil-but that we won't, because we will not take the necesary steps in terms of efficiency and conservation.

MAC -- What concerns me the most is the extension of your very valid observations. Businesses will economize as best as possible. But, after the initial efficiency gains, what will they do next? Reducing staff would seem to be the only major adjustment available. Add the potential of higher energy prices with the potential tax increases to support healthcare reform and I think we might look back on the last couple of years as not so bad in comparison. I know it's a hackneyed phrase but it really does look like we could be heading to that perfect economic storm especially when you add in the debt/inflation/reduced capital availablity/aging baby boomers/etc factors.

Rockman,I am sure we are in for some extended rough economic weather.Reducing staff is indeed about the only thing a business in trouble can do, excepting cutting out research/development and capital investment.

As bad as the budget situation looks I am now in favor of what must now be described as socialized medicine in this country even though I am adamantly opposed philosophically to the govt running things if it can be avoided.

As I see it now establishing a national health care plan is fully justified on moral grounds-if we can afford to bail out the big players at the expense of the little ones, we can just go ahead and put the health care industry on the national credit card as well.It's only fair, and if we go busted,as seems inevitable, I would like to know that some of the money went to a better purpose than supporting gold in sacks.(In hillbilly "broke " means you are headed towards bankruptcy court. Busted means you are there.)

Furthermore it seems that this will be a good precautionary measure that will; go a long ways towards maintaining public order if things keep getting worse.Somethin g will have to be done to clothe, feed, and shelter the people who are out of work and near the end of thier ropes.

Else we might find ourselves in the situation of a banana republic -riots,refugee camps, steadily increasing crime,probably the rise of some sort of really nasty political party that might get into office.

I have been reading William L. Shirer's "Twentieth Century Journey" this week-the memoirs of one of the foremost reporters /journalists of the Nazi /WWII era.

It is eerie how well his growing awareness of the worlds headlong plunge towards war in the thirties matches up to our awareness of the energy situation.

Nobody then in a position of authority would look squarely at the evidence then with a couple of notable exceptions.Everybody was absorbed in the other "more pressing" business of the day and the voives in the wilderness werte ignored-even as the riots took place, as the fighting actually started in many places.

It might surprise some Mac but I could fully support completely socialized medicine. But only in theory. There is no plan, however well designed, that can succeed when poorly executed. Based upon pass preformance I have zero confidence in the gov't getting it right. In fact, I feel it's likely that health care for the poor will degarde from where it is today if current plans are inacted to a significant degree. It's those damn unintended consequencies they never put into their forecasts.

I do believe it is possible to have a robust economy on a lot less oil-but that we won't, because we will not take the necesary steps in terms of efficiency and conservation.

Ironically at 7:00 AM this morning I was plowing through the breaking surf north of port Everglades Inlet in my kayak heading out with some friends to watch the arrival of the largest Royal Caribbean Cruise Ship ever built. All I could think of was this sure beats the biggest heads on Easter Island.

I assume that Royal Caribbean is sure it has built the most fuel efficient ship that money could buy.

I just can't imagine that that in the current economic context there will be enough passengers to keep this viable. Perhaps they know something the rest of us do not?

I don't see anything in your analysis re: lags. i.e. how high for how long are sustained higher prices required to bring forth new supplies?

The lags in the oil production side of the ledger are what cause periodic gluts and famines.

The other thing to consider is the politics of oil. What if countries that own the oil do not invest sufficiently in maintenance and new production? Venezuela and Iran being the most notorious examples. What about countries that subsidize consumption?

What about the USA which makes much of its reserves off limits to production? (tar sands, offshore drilling, Alaska)

There are all kinds of details that confound your analysis. Reminds me of the "chartist investors". The charts explain nothing. Their predictive ability is limited.

Everything you posit makes sense if corporations are in charge of production. They are not. Decisions are not made on the basis of dollars but on politics. You know - Iran wants to fight a war with the West and thus eats its oil capital. Venezuela wants to support its socialism with oil. And they need the money NOW. Environmentalists do not want drilling off Santa Barbra despite all the oil seeping out of the ocean in that area.

Beware email scams!

Beware email scams claiming to be from this site. We do not have any job openings. If anyone contacts you about a job at The Oil Drum, do not reply to them, and definitely do not give them any personal information or send them money. Read more here.

“A third of humanity doesn't want to ride bikes anymore; that has profound geopolitical implications.”

—Anne Korin, the co-director of the Institute for the Analysis of Global Security (May 1, 2005)